Friday, 26 May 2017

“Invest in infrastructure while interest rates are low” is a flawed argument.


The above is a popular idea, backed by any number of professional economists. In fact I don’t know of a professional economist who questions the idea.

Unfortunately there is a glaring flaw in the idea, namely that interest rate changes are to a significant extent artificial: certainly central banks THINK they have a big influence on interest rates, and that idea is widely accepted.

Interest rates have of course fallen all of their own accord over the last twenty five years or so, but that fall has been accentuated by central banks since the 2008 crisis.

Thus when it comes to the question as to how much to spend on infrastructure and other investments, what might be called the GENUINE fall in interest rates is a valid reason for spending more. But that reason for more infrastructure investment was valid just before the crisis hit. So did we hear repeated calls for more infrastructure investment at that time? Nope. We had almost complete silence.

Then come the crisis, and so called “professional” economists all started demand more infrastructure spending. In fact there was no more reason for such spending just after the crisis hit than just before.

Put another way, the artificial fall in interest rates is NOT a valid to spend more.

Indeed the latter point gains support from a brief look at how central banks actually cut interest rates: they do it by printing money and buying up government debt. What was that – “printing money”?

Hang on: if the state can just print money (which it can in a country that issues its own currency) why have government borrow at all??? I.e. what’s the point of borrowing money if you can print the stuff (and spend it on infrastructure or whatever)? There’s no point.!!

Put yet another way, why not just print money and spend on any selection of the usual public spending items (education, health, defence, etc). Alternatively, those with right of centre views might want to print money and “spend” that on tax cuts: i.e. have the additional spending come in the form of additional HOUSEHOLD spending.

Indeed, the latter is essentially a form of “helicopter drop” and the latter is widely regarded as a reasonable or viable form of stimulus.

But if one goes for printing / helicoptering, there is no obvious reason to give infrastructure investments any sort of priority. That is, for the purposes of unemployment reduction and getting the economy up to capacity, spending on CURRENT rather than CAPITAL items will do perfectly well. Indeed, “current spending” is probably better than capital spending in that it takes time (sometimes several years) to get infrastructure projects going.

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P.S. The above argument could be criticised on the grounds that the WHOLE POINT of artificial interest rate cuts is to encourage borrowing and investment. However that is a weak criticism. Reason is that infrastructure lasts 50 or 100 years and there is no reason to suppose that interest rates over that period will be much reduced just because there was a recession which started around 2008. In contrast, loans for consumer durables last a much shorter time. So for the latter products, artificially reducing interest rates with a view to expanding demand makes more sense.

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